Apple Music could kill Spotify and still be a failure

Most stories about Apple Music focus on how the new service  will be battling for subscribers against popular competitors like Spotify and Deezer.

But to the music industry, and likely to Apple (AAPL) itself, that battle is almost irrelevant. That's because only one in 20 U.S. adults subscribes to a music service now, a paltry level of penetration that must grow exponentially -- and fast -- to prevent the industry's revenue from falling off a cliff.

"The big win for everyone is if this grows the streaming pie," says Geoffrey Mayfield, a consultant who used to work for Universal Music Group. "But if Apple's just stealing away customers from the other services, that's not going to help anyone."

The early signs are good, from the industry's perspective. Since June 30, over 40% of iPhone and iPad owners upgraded to the new software that includes Apple Music, according to market tracker Mixpanel. That's almost half the time it took the last big upgrade, iOS 8, to reach 40% adoption. And Apple has already backed Apple Music with a sexy television ad campaign, something it never did for its iTunes Radio effort two years ago.

But it's much too early to tell whether Apple Music will be a breakout hit and the challenges are enormous. With the lengthy three month free trial, no one will be required to pay a cent until October. And a version of the app for the majority of the world, Android phone users, isn't expected for another few months, as well.

Falling music sales

The industry needs a hit. Revenue from digital song and album downloads dropped 9% to $2.6 billion last year, according to the Recording Industry Association of America. Sales of physical music on CDs and vinyl declined 7% to $2.3 billion. The only positive note was online, where subscriptions and ad-supported streaming brought in $1.9 billion, a 29% increase. The under $7 billion total pales in comparison to the $12.3 billion ($15.5 billion adjusted for inflation) that U.S. music brought in overall a decade earlier.

The trends continued through the first half of 2015, according to Nielsen, which measures the number of sales, not revenue. Sales of physical and digital albums declined another 4% and singles dropped 10% as the number of streamed songs jumped 92%.

While the music industry remains hopeful that Apple can give that growth rate a mega-boost, the challenges are substantial. Apple's own track record of late with music hasn't been very good. It has been over a decade since Steve Jobs created a paid marketplace for music in iTunes that succeeded despite rampant piracy. More recently, Apple's Pandora (P) clone, iTunes Radio, has been a dud and its earlier music-oriented social network, Ping, was a complete disaster.

Only 8% of online radio listeners say iTunes is their top pick, according to a recent survey by Edison Research, versus 54% for market leader Pandora, 11% for iHeartRadio and 10% for Spotify. And Ping? Steve Jobs launched Apple’s supposed social network for music with great fanfare in 2010 as "sort of like Facebook and Twitter meet iTunes," but within two years it was killed.

That's why the initial mixed reviews of Apple Music have concerned some analysts. Recode's Walt Mossberg called it "uncharacteristically complicated by Apple standards," a common theme. The Verge described the service as "an impressive if slightly confusing first cut."

Others are less charitable. "I don't want to quite say it's a disaster, but by Apple standards, it's a disaster," says Bob Lefsetz, a former music industry exec who writes a widely followed email newsletter.

Apart from the complexity, the app's social sharing side, a network dubbed Connect, seems far more limited than competing products at a time when hit songs come out of shared playlists.

Lourde's popularity took off after Napster creator Sean Parker added her song "Royals" to a playlist he shares on Spotify, for example. But Connect only lets musicians make posts and the posts can only be shared via other social networks like Twitter (TWTR) and Facebook (FB). Although Apple has recruited a few tastemakers to create playlists, it's a highly restricted, media-centric group including GQ, Pitchfork and Rolling Stone. There's nothing organic or viral about it. In fact, it's reminiscent of the goofy celebrity playlists iTunes featured a decade ago.

"The research says Spotify's approach is pretty effective," says Russ Crupnick, managing partner at MusicWatch. "People love Spotify. There's a lot of loyalty there."

Getting people to pay up

The biggest challenge facing Apple, however, appears to be the price of the service. As noted, very few people in the U.S. have so far shown a willingness to pay the music industry's standard $10-per-month fee. Apple initially tried to move the industry to a lower number, citing research that even people who bought songs on iTunes regularly spent only about $60 per year on average.

But the industry rejected that approach. People in the music business are quick to point to success stories in other media segments. Netflix (NFLX) has 40 million U.S. subscribers paying $8 a month or more. Hulu has another nine million. Sirius XM (SIRI) has over 27 million paying customers for satellite radio.

The fundamental problem for the music industry -- though certainly not for consumers -- is that there are just so many free alternatives to paying for a music subscription. Broadcast radio remains free and vastly popular, while most consumers who use Pandora and other online services opt for the same free-with-advertising deal. And while Apple Music has no free tier, most on-demand services like Spotify, Deezer and Rdio offer one. And Apple's peers, Amazon (AMZN), Google (GOOGL) and Microsoft (MSFT) have music offerings with plenty of features to appeal to cheapskates.

Finally, the king of online music -- Google's YouTube -- remains completely free, though a pay offering called YouTube Music Key is in limited testing.

Apple music could be a big success within the small group of people willing to pay $10 a month, but that might not be very many people. Only 5% of U.S. consumers pay for streaming now, according to a Nielsen survey. And while on average people spend $109 a year on music, more than half of that is for attending live events. The total for buying music in all formats plus streaming services averages just under $36 a year.

"A year from now, if Apple's doubled the number of paid subscribers, they'll probably see that as a success," says Crupnick. "I'm not sure the record labels or the industry would agree."